Volatility Information Trading in the Option Market

36 Pages Posted: 6 Oct 2005

See all articles by Sophie Xiaoyan Ni

Sophie Xiaoyan Ni

Hong Kong Baptist University (HKBU)

Jun Pan

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA); National Bureau of Economic Research (NBER); China Academy of Financial Research (CAFR)

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: September 20, 2005

Abstract

This paper investigates informed trading on stock volatility in the option market. Using a unique data set from the Chicago Board Options Exchange, we construct non-market maker net demand for stock volatility from the trading volume of individual equity options. We find that this volatility demand is informative about the future realized volatility of underlying stocks which suggests the presence of volatility information traders in the option market. We also examine asset pricing implications of volatility information trading by measuring Kyle's lambda: The impact on option prices for each unit increase in volatility demand. The price impact is positive which is consistent with the existence of informational asymmetry about stock volatility. More importantly, we link the time variation in the price impact to the time variation in the degree of informational asymmetry. In particular, the price impact increases by over 50 percent as informational asymmetry about stock volatility intensifies in the days leading up to earnings announcements and diminishes to its normal level soon after the volatility uncertainty is resolved.

Keywords: options, derivatives, information, volatility

JEL Classification: G10, G12, G13, G14

Suggested Citation

Ni, Sophie Xiaoyan and Pan, Jun and Poteshman, Allen M., Volatility Information Trading in the Option Market (September 20, 2005). Available at SSRN: https://ssrn.com/abstract=809107 or http://dx.doi.org/10.2139/ssrn.809107

Sophie Xiaoyan Ni

Hong Kong Baptist University (HKBU) ( email )

Kowloon
Hong Kong

HOME PAGE: http://sites.google.com/site/sophiexni/

Jun Pan

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States
617-253-3083 (Phone)
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National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

Allen M. Poteshman (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

340 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-265-0565 (Phone)
217-244-3102 (Fax)

HOME PAGE: http://www.business.uiuc.edu/poteshma

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